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Tuesday, November 6, 2007

The media, particularly the financial press, are all agog overthe rise of China and India in the international economy. After a long period of relative stagnation, these two countries, nearly two-fifths of the world population, have seen their incomes grow at remarkably high rates over the last two decades. Journalists have referred to their economic reforms and integration into the world economy in all kinds of colorful metaphors: giants shaking off their "socialist slumber," "caged tigers" unshackled, and so on.Columnists have sent breathless reports from Beijing and Bangalore about the inexorable competition from these two new whiz kids in our complacent neighborhood in a "flattened," globalized, playing field. Others have warned about the momentous implications of "three billion new capitalists," largely from China and India, redefining the next phase of globalization.

While there is no doubt about the great potential of these two economies in the rest of this century, severe structural and institutional problems will hobble them for years to come. At this point, the hype about the Indian economy seems patently premature, and the risks on the horizon for the Chinese polity – and hence for economic stability – highly underestimated. Both China and India are still desperately poor countries. Of the total of 2.3 billion people in these two countries, nearly 1.5 billion earn less than US$2 a day, according to World Bank calculations. Of course, the lifting of hundreds of millions of people above poverty in China has been historic. Thanks to repeated assertions in the

international financial press, conventional wisdom now suggests that globalization is responsible for this feat. Yet a substantial part of China's decline in poverty since 1980 already happened by mid-1980s (largely as a result of agricultural growth), before the big strides in foreign trade and investment in the 1990s. Assertions about Indian poverty reduction primarily through trade liberalization are even shakier. In the nineties, the decade of major trade liberalization, the rate of decline in poverty by some aggregative estimates has, if anything, slowed down. In any case, India is as yet a minor player in world trade, contributing less than one percent of world exports. (China's share is about 6 percent.)

What about the hordes of Indian software engineers, call-center operators, and back-room programmers supposedly hollowing out white-collar jobs in rich countries? The total number of workers in all possible forms of IT-related jobs in India comes to less than a million workers – one-quarter of one percent of the Indian labor force. For all its Nobel Prizes and brilliant scholars and professionals, India is the largest single-country contributor to the pool of illiterate people in the world. Lifting them out of poverty and dead-end menial jobs will remain a Herculean task for decades to come. Even in China, now considered the manufacturing workshop of the world (though China's share in the worldwide

manufacturing value-added is below 9 percent, less than half that of Japan or the United States), less than one-fifth of its labor force is employed in manufacturing, mining, and construction combined.

In fact, China has lost tens of millions of manufacturing jobs since the mid-1990s. Nearly half of the country's labor force remains in agriculture (about 60 percent in India). As per acre productivity growth has stagnated, reabsorbing the hundreds of millions of peasants will remain a challenge in the foreseeable future for both countries. Domestic private enterprise in China, while active and growing, is relatively weak, and Chinese banks are burdened with "bad" loans. By most aggregative measures, capital is used much less efficiently in China than in India, even though in terms of physical infrastructure and progress in education and health, China is better poised for further economic growth. Commercial regulatory structures in both countries are still slow and heavy-handed. According to the World Bank, to start a business requires in India 71 days, in China 48 days (compared to 6 days in Singapore); enforcing debt contracts requires 425 days in India, 241 days in China (69 days in Singapore).

China's authoritarian system of government will likely be a major economic liability in the long run, regardless of its immediate implications for short-run policy decisions. In the economic reform process, the Chinese leadership has often made bold decisions and implemented them relatively quickly and decisively, whereas in India, reform has been halting and hesitant. This is usually attributed to the inevitably slow processes of democracy in India. And though this may be the case, other factors are involved. For example, the major disruptions and hardships of restructuring in the Chinese economy were rendered somewhat tolerable by a minimum rural safety net – made possible to a large extent by land reforms in 1978. In most parts of India, no similar rural safety net exists for the poor; and the more severe educational inequality in Indiamakes the absorption of shocks in the industrial labor market moredifficult. So the resistance to the competitive process of marketreform is that much stiffer.

But inequalities (particularly rural-urban) have been increasing in China, and those left behind are getting restive. With massivelayoffs in the rust-belt provinces, arbitrary local levies on farmers, pervasive official corruption, and toxic industrial dumping, many in the countryside are highly agitated. Chinese police recordsindicate a sevenfold increase in the number of incidents of social unrest in the last decade.

China is far behind India in the ability to politically manage conflicts, and this may prove to be China's Achilles' Heel. Over the last fifty years, India's extremely heterogeneous society has been riddled with various kinds of conflicts, but the system has by and large managed these conflicts and kept them within moderate bounds. For many centuries, the homogenizing tradition of Chinese high culture, language, and bureaucracy has not given much scope to pluralism and diversity, and a centralizing, authoritarian Communist Party has carried on with this tradition. There is a certain pre-occupation with order and stability in China (not just in the Party), a tendency to over-react to difficult situations, and a quickness to brand dissenting movements and local autonomy efforts as seditious, and it is in this context that one sees dark clouds on the horizon for China's polity and therefore the economy.

We should not lose our sense of proportion in thinking about the rise of China and India. While adjusting its economies to the new reality and utilizing the new opportunities, the West should not overlook the enormity of the economic gap that exists between it and those two countries (particularly India). There are many severe pitfalls and roadblocks which they have to overcome in the near future, before they can become significant players in the international economic scene on a sustained basis.